Michael Shulman

The Safest Way to Short the Homebuilders

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Wall Street is beginning to lose patience with the homebuilders.

If you talk to the bulls, homebuilding stocks are trading at all-time lows and should be bought now. If you talk to the bears, the businesses are broken. Well, I'm a market agnostic, and I see the industry as collectively bankrupt within a year, with several players possibly folding in the next six to 24 months.

Why?

• The market is flooded with unsold homes, plus analysts estimate 7 million more homes will be put on the market in the next three to 18 months due to foreclosures. Too much inventory means there is no need to build more homes and that prices will continue to drop on homes that have already been built.

 

• More than one-third of all American homeowners said they would sell their homes if they could. This means that, as prices stabilize, we'll likely see inventory increase. 

 

• Historically, the industry rebounds when it hits a build rate of 1 million units per year. We are at half that rate and have been for a year -- the business model is broken and these guys are burning cash.

When the homebuilders hit bottom, they often trade for half of book value. DR Horton (DHI) is now trading for 1.5 times tangible book, while KB Home (KBH) is trading for 1.9 times. Historically, the industry average is 1.6. But do you think we live in average times?

If you think it's too risky to pick the individual losers to short with put options, then why not take a look at the exchange-traded fund (ETF) that represents the homebuilding segment, including suppliers: SPDR Homebuilders ETF (XHB).

Take a look at puts on XHB at least six months out.  

Let Michael Shulman help you make money on the short side of the stock market. Download a free copy of his new investing guide, Double Your Money -- and Double it Again.